RBI<\/a> has injected such an extraordinary amount of systemic liquidity that bond yields are not only soft but are continuing to soften further,\u201d Subbarao said. (File image)<\/span><\/figure>\n<\/div>\nFormer RBI Governor D Subbarao on Friday said India is not close to the situation where the central bank has to go for debt monetisation amid rising government spending and falling revenue collection due to the COVID-19 crisis.<\/p>\n
The case for direct financing is made on the argument that government borrowing this year has ballooned way beyond normal, Subbaro said.<\/p>\n
Generally, monetisation of debt means the central bank printing currency for the government to take care of any emergency spending and to bridge its fiscal deficit.<\/p>\n
\u201cThere just aren\u2019t enough savings in the economy to finance borrowing of such a large size. Bond yields would spike so high that financial stability will be threatened. The RBI must therefore step in and finance the government directly to prevent this from happening,\u201d he said.<\/p>\n
Referring to the idea of debt monetisation, Subbarao said, \u201cthere is no reason to believe that we are anywhere close to that situation\u201d.<\/p>\n
\u201cThrough its Open Market Operations (OMOs), the RBI has injected such an extraordinary amount of systemic liquidity that bond yields are not only soft but are continuing to soften further,\u201d he said.<\/p>\n
\u201c\u2026 right now, the government is able to borrow at a real rate of zero per cent. How do you justify direct monetisation in such a scenario?,\u201d he wondered.<\/p>\n
Subbarao was speaking at a virtual event to release a book titled \u2018Quest for Restoring Financial Stability in India\u2019 by former RBI Deputy Governor Viral V Acharya.<\/p>\n
Earlier this month, Economic Affairs Secretary Tarun Bajaj said that monetisation of debt is not on the government\u201ds agenda at the moment as there are some positive signs on the revenue collection front.<\/p>\n
According to Subbarao, both monetisation and OMOs involve expansion of money supply which can potentially stoke inflation.<\/p>\n
\u201cBut the inflation risk they carry is different. OMOs are a monetary policy tool with the RBI in the driver\u2019s seat, deciding on how much liquidity to inject and when.<\/p>\n
\u201cIn contrast, monetisation is and is seen, as a way of financing the fiscal deficit with the quantum and timing of money supply determined by the government\u2019s borrowing rather than the RBI\u2019s monetary policy,\u201d he said.<\/p>\n
In spite of all this, he said that if the government decides to cross the rubicon, the markets will fear that the government is abandoning all constraints on fiscal policy and is planning to solve its fiscal problems by inflating its debt.<\/p>\n
If that happens, yields on government bonds will shoot up, the opposite of what is sought to be achieved, he noted.<\/p>\n
\u201cFor sure, monetisation, despite its costs, might become inevitable at some point in the future. If the government cannot finance its deficit at reasonable rates and bond yields spike so high as to threaten financial instability, there may be no alternative to direct monetisation. We are not there yet,\u201d he said.<\/p>\n
In the wake of the COVID-19 crisis, revenue collections have taken a hit and the government spending is also on the rise.<\/p>\n
On the inflation target framework for fixing benchmark interest rate by the Monetary Policy Committee (MPC), Subbaro said it has not been fully tested.<\/p>\n
RBI has initiated a review of the retail inflation targeting framework behind monetary policy decisions as well as its effectiveness.<\/p>\n
In a bid to keep inflation under a specified level, the government, in 2016, had decided to set up the MPC headed by RBI Governor to decide the benchmark policy rate.<\/p>\n
The six-member panel, which had its first meeting in October 2016, was given the mandate to maintain annual inflation at 4 per cent until March 31, 2021 with an upper tolerance of 6 per cent and a lower tolerance of 2 per cent.<\/p>\n
Subbaro said the four-year period since 2016 when RBI embarked on the inflation targeting framework has been unusually benign from an inflation perspective.<\/p>\n
\u201cPrivate demand for credit has been low because of, among other things, the NPA problem; so, not much demand push inflation. Globally there have been no hiccups on the financial stability front up until the corona crisis hit us six months ago. Yes, the corona crisis has turned our world upside down and caused a host of problems but not much on the inflation front,\u201d he said.<\/p>\n
In short, Subbarao said there has been no extraordinary circumstance to challenge the efficacy of the inflation targeting framework.<\/p>\n
About the book and its author, Subbarao said the conviction and concern with which Acharya narrates the frontline battles of a policymaker to influence economic policy debates is the reason for recommending the book.<\/p>\n
\u201cAcharya served the RBI and the nation with dignity and distinction. He will certainly go down in the history of the RBI as one of its most influential deputy governors,\u201d he added.<\/p>\n
Acharya, who reportedly had differences with the government and made a fervent pitch for autonomy for the regulator, quit RBI in July 2019, six months ahead of his three-year term.
At the event, former RBI Governor Y V Reddy said issues relating to financial stability in India have become more complex and more challenging.<\/p>\n
\u201cIn addition, the spread of virus has imparted more complications and greater urgency to address the problem of financial stability in the face of unprecedented fiscal challenges. In this background, the book is of special and urgent contemporary interest,\u201d Reddy said.<\/p>\n
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